Question

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You are currently working at a mid-sized certified public accounting firm. Your client is Bob Jones. Bob, age 60 and single, has recently retired from IBM. He has $690,000 available in his 401(k) fund and he is thinking of using that money to open a used car business that will be located at 210 Ocean View Drive in Pensacola, Florida. Bob has estimated that the business might make $300,000 in taxable income. Bob’s personal wealth including investments in land, stocks, and bonds is about $14,000,000. He reported an interest income of $20,000 and dividend income of $6,000 last year. The $14,000,000 includes land worth $9,000,000 that Bob bought in 1966 for $450,000. Bob has hired your firm for professional advice regarding whether he should operate as a sole proprietor, a partnership, an S corporation, or a C corporation. He is also considering transferring a possible 40% interest in his new business to his daughter Mandy, age 23 and single.

Required

1-Differentiate between accrual accounting and cash basis.

2-Based on the type of business and the client’s accounting system, what is the impact when revenue is recognized?

Answer 1

Answers:

1-Differentiate between accrual accounting and cash basis.

2-Based on the type of business and the client’s accounting system, what is the impact when revenue is recognized?

Comparison Chart

BASIS FOR COMPARISON	CASH ACCOUNTING	ACCRUAL ACCOUNTING
Meaning	The accounting method in which the income or expense is recognized only when there is actual inflow or outflow of cash.	The accounting method in which the income or expense is recognized on mercantile basis.
Nature	Simple	Complex
Method	Not recognized method as per companies act.	Recognized method as per companies act.
Income statement	Income statement shows lower income.	Income statement will show a comparatively higher income.
Applicability of matching concept	No	Yes
Recognition of revenue	Cash is received	Revenue is earned
Recognition of expense	Cash is paid	Expense is incurred
Degree of Accuracy	Low	Comparatively high

Conclusion

Cash Basis And Accrual Basis Of Accounting

Cash basis and accrual basis are accounting methods that differ based on the timing of when revenues and expenses are recognized. When a company uses cash basis accounting, it recognizes revenues when cash is actually received and expenses at the time they are actually paid. With accrual accounting, income is recognized at the time revenue is earned (which may not be when it is received) and expenses are recorded when liabilities are incurred (which may not be when they are paid). The benefit of accrual accounting is a more accurate measure of a company's profitability. To comply with GAAP, businesses are required to use the accrual basis. The cash basis is often used by small companies and individuals because it is simpler and less costly.